DoD budget cuts aimed at avoiding termination fees

Feb. 21, 2012 - 06:00AM
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The L-3 Communications-Alenia C-27J cargo plane is among the 20 major programs the Pentagon has proposed canceling or changing production schedules in a move officials say will save $75 billion over the next five years. (Senior Master Sgt. David Lipp / Air Force)

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The Defense Department carefully selected the programs it wants to cancel in fiscal 2013 to avoid termination fee negotiations that have plagued the Pentagon in prior years.

In some cases, DoD will simply let existing production contracts expire and take delivery of new aircraft, only to turn around and park them in the desert, just to avoid the headache of stopping these efforts midstream.

"These select number of program kills are really things that … appear to have been very carefully thought out to have the minimum quantity of termination liability associated with them to begin with," said Jim McAleese, who runs McAleese & Associates, a Virginia-based consulting firm.

This fact could make this year's cuts less costly than those made in 2010. DoD is still negotiating termination fees with Boeing for the Army's Future Combat System, which was canceled in 2010.

In the budget submitted Feb. 13, the DoD proposed canceling or changing production schedules for about 20 major programs, a move defense officials claim will save it $75 billion over the next five years.

Although the costs associated with ending these efforts might not be that large, the amount of money already spent on them is substantial — at least $6.8 billion, according to DoD budget documents.

To put this in perspective, the Air Force could have used that money to purchase 47 F-22A Raptors, the Army could have sustained about 80,000 soldiers for a year, the Navy could have purchased almost half an aircraft carrier or Norway could run its entire military.

Over the past 10 years, the Pentagon has spent about $46 billion, using current dollar estimates, on development programs that were terminated and never entered production, according to a July 2011 report by Todd Harrison at the Center for Strategic and Budgetary Assessments.

Still, the proposed cancellations themselves are not likely to cost DoD much. It appears that the programs eyed for axing in 2013 are not locked into multiyear or extensive contracts, meaning there would be less cost incurred by DoD when canceling them.

The cost of canceling the programs in 2013 is dependent on the type of contract. How the government cancels a contract is also a factor. If the government terminates a contract for cause — meaning poor performance or being over budget — it might not be responsible for a termination fee. Terminating for convenience is a different issue.

"If it's not well-defined in the contract to get out of the contract, you may have to negotiate to pay even more to a contractor for them to be willing to let you out of it," Harrison said. "A lot of these savings from cutting these things, these are just estimates. They don't really know what the termination costs are going to be until they try to do it."

Calculating the termination cost for these programs is difficult because individual contract language is unique.

"If you ... signed a contract and said, ‘We're going to buy 10 of these platforms.' They ramp up, hire people and start ordering materials in line with your contract, and when you terminate it, they've got costs," Harrison said.

There are enough funds from within existing program accounts to cover termination liabilities, Lt. Col. Elizabeth Robbins, a Pentagon spokeswoman, wrote in an email on Friday. DoD has just begun termination discussions with contractors, she said.

The proposed cancellations and program restructures in 2013 are part of a Pentagon goal to cut $487 billion in planned spending from its budget over the next decade. The cuts were mandated by the Budget Control Act of 2011, a law designed to help lower the U.S. deficit.

The first part of those cuts, totaling about $259 billion, is outlined in DoD's 2013 budget proposal, which was submitted Feb. 13.

The Air Force has spent $3.4 billion developing and purchasing 18 Block 30 Global Hawk aircraft, according to Jennifer Cassidy, a service spokeswoman.

The service — which had originally planned to buy 42 Block 30 Global Hawks —- has not yet issued a stop-work order to Northrop.

The Air Force has issued a stop-work order on the Boeing C-130 AMP, which was about to begin initial flight tests. The company has delivered three modified aircraft and the Air Force has modified one on its own using the upgrade kit built by Boeing, said Jennifer Hogan, a Boeing spokeswoman.

Budget documents show the Air Force has spent at least $2.1 billion on the C-130 avionics program. The Pentagon already has spent at least $1.2 billion buying 21 C-27Js, according to budget documents.

In all, the Air Force has received 12 of 21 ordered C-27Js. Two of those aircraft are operating in Afghanistan. The Air Force plans to take delivery of the remaining C-27J and then retire them. It also plans to retire the Block 30 Global Hawks.

All together, DoD says canceling these three programs will save it $5.2 billion over the next five years, $2.5 billion for Global Hawk, $2.3 billion for C-130 AMP and $400 million for C-27J.

While DoD sees savings, particularly from slowing purchases, this move will also raise the per-unit cost of targeted systems in the near term.

"[T]hat's a fair point," DoD Comptroller Robert Hale said when asked about stretching program buys out during a Feb. 13 briefing at the Pentagon. "If we had our way, we probably wouldn't have done it."

Hale noted that the Budget Control Act required DoD to cut spending.

"We tried to do them in a way that minimized the adverse effects," Hale said.